UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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WASHINGTON, D.C. 20549

FORM 8-K
CURRENT REPORT

Pursuant To Section 13 or 15 (d) of the
Securities Exchange Act of 1934

Date of Report (date of earliest event reported):

MAY 11, 2005

PETROHAWK ENERGY CORPORATION

(832) 204-2700
(Registrant’s telephone number, including area code)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

 

Item 8.01 Other Events

On April 4, 2005, Petrohawk Energy Corporation, a Delaware corporation (“Petrohawk”), and Mission Resources Corporation, a Delaware corporation (“Mission”), announced the execution of an Agreement and Plan of Merger, dated as of April 3, 2005, by and among Petrohawk, Mission, and Petrohawk Acquisition Corporation, a Delaware corporation and wholly owned subsidiary of Petrohawk, pursuant to which Petrohawk has agreed to purchase all of the issued and outstanding shares of Mission common stock. In connection therewith, Petrohawk is filing Mission’s historical financial information and Petrohawk’s pro forma financial information as though the pending merger had been completed as of the dates indicated.

Item 9.01 Financial Statements and Exhibits

(a) Financial Statements of Business to be Acquired.

     Following are Mission’s consolidated financial statements as of December 31, 2003 and 2004 and related notes, as contained in Mission’s Annual Report on Form 10-K/A for the period ended December 31, 2004 (File No. 000-09498).

INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

2

3

MISSION RESOURCES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

MISSION RESOURCES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS — (Continued)

See Notes to Consolidated Financial Statements.

MISSION RESOURCES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See Notes to Consolidated Financial Statements.

MISSION RESOURCES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES

IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME OR LOSS

See Notes to Consolidated Financial Statements.

MISSION RESOURCES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Consolidated Financial Statements.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements

      Mission Resources Corporation (the “Company” or “Mission”) is an independent oil and gas exploration and production company. We develop and produce crude oil and natural gas. Mission’s balanced portfolio comprises assets located in the Permian Basin (West Texas and Southeast New Mexico), along the Texas and Louisiana Gulf Coast and in the Gulf of Mexico. Our operational focus is on property enhancement through development drilling, operating cost reduction, low to moderate risk exploration, asset redeployment and acquisitions of properties in the right circumstances.

      The consolidated financial statements include the accounts of Mission Resources Corporation and its wholly owned subsidiaries. Mission owns a 26.6% interest in the White Shoal Pipeline Corporation that is accounted for using the equity method. Mission’s net investment of approximately $237,000 at December 31, 2004 is included in the other assets line of the Consolidated Balance Sheet. Mission had a 10.1% ownership in the East Texas Salt Water Disposal Company that was accounted for using the cost method. It was reported at $861,000 in the other assets line of the Consolidated Balance Sheet at December 31, 2002. This interest was sold in December 2003 in connection with the sale of several oil and gas properties in the East Texas area.

      Full Cost Pool — The Company utilizes the full cost method to account for its investment in oil and gas properties. Under this method, all costs of acquisition, exploration and development of oil and gas reserves (including such costs as leasehold acquisition costs, geological expenditures, dry hole costs and tangible and intangible development costs and direct internal costs) are capitalized as the cost of oil and gas properties when incurred. Direct internal costs that are capitalized are primarily the salary and benefits of geologists, landmen and engineers directly involved in acquisition, exploration and development activities, and amounted to $2.1 million, $1.8 million, and $1.3 million in the years ended December 31, 2004, 2003 and 2002, respectively

      Depletion — The cost of oil and gas properties, the estimated future expenditures to develop proved reserves, and estimated future abandonment, site remediation and dismantlement costs are depleted and charged to operations using the unit-of-production method based on the ratio of current production to proved oil and gas reserves as estimated by independent engineering consultants as of the beginning of the reporting period. Depletion expense per thousand cubic feet of gas equivalent (“MCFE”) was approximately $1.80 in 2004, $1.65 in 2003, and $1.29 in 2002.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      Unproved Property Costs — Costs directly associated with the acquisition and evaluation of unproved properties are excluded from the amortization computation until it is determined whether or not proved reserves can be assigned to the properties or whether impairment has occurred. The following table shows, by category of cost and date incurred, the domestic unproved property costs excluded from amortization (amounts in thousands):

      Such unproved property costs fall into four broad categories:

      Approximately $1.2 million, $2.8 million, and $2.2 million were evaluated and moved to the full cost pool in 2004, 2003 and 2002, respectively.

      Sales of Properties — Dispositions of oil and gas properties held in the full cost pool are recorded as adjustments to net capitalized costs, with no gain or loss recognized unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas. Net proceeds from property sales of $13.0 million, $28.1 million and $60.4 million were recorded as adjustments to net capitalized costs during the years 2004, 2003 and 2002, respectively.

      Impairment — To the extent that capitalized costs of oil and gas properties, net of accumulated depreciation, depletion and amortization, exceed the discounted future net revenues of proved oil and gas reserves net of deferred taxes, such excess capitalized costs would be charged to operations as an impairment. Oil and gas prices as of December 31, 2004 were $43.33 per barrel of oil (NYMEX WTI Cushing) and $6.18 per MMBTU of gas (NYMEX Henry Hub). Such closing prices, adjusted to the wellhead to reflect adjustments for marketing, quality and heating content, were used to determine discounted future net revenues for the Company. In addition, the Company adjusted discounted future net revenues to reflect the potential impact of its commodity hedges that qualify for hedge accounting under SFAS No. 133. This adjustment was calculated by taking the difference between the closing NYMEX spot prices and the price ceiling on the Company’s hedges multiplied by the hedged volumes that were included in proved reserves. This calculation resulted in a decrease in discounted future net revenues of $11.0 million because prices prevailing at December 31, 2004 were higher than most of the Company’s price ceilings.

      The Company’s capitalized costs were not in excess of these adjusted discounted future net revenues as of December 31, 2004 and 2003; therefore no impairment was required.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      Any reference to oil and gas reserve information in the Notes to Consolidated Financial Statements is unaudited.

      The accrued liabilities line of the Consolidated Balance Sheet includes approximately $3.2 million of royalties that are awaiting completion of title opinions. Upon receipt of the title opinions and executed division orders, Mission will be required to make payment. This liability may increase in size as the well produces or decrease as title opinions are completed and royalties paid. Typically, royalties are paid within one to two months after the production is sold.

      Revenues are recognized and accrued as production occurs. In 2002, no one customer accounted for greater than 10% of oil and gas revenues. In 2003 and 2004, sales to Shell Trading (US) Company totaled approximately $19.7 million and $35.7 million, respectively, and accounted for 21.5% and 26.4%, respectively, of the Company’s oil and gas revenues exclusive of the impact of hedges. Also in 2004, sales to Conoco Phillips Company totaled approximately $16.2 million and accounted for 12.0% of the Company’s oil and gas revenue exclusive of the impact of hedges.

      The Company uses the sales method of accounting for revenue. Under this method, oil and gas revenues are recorded for the amount of oil and natural gas production sold to purchasers. Gas imbalances are created, but not recorded, when the sales amount is not equal to the Company’s entitled share of production. The Company’s entitled share is calculated as the total or gross production of the property multiplied by the Company’s decimal interest in the property. No provision is made unless the gas reserves attributable to a property have depleted to the point that there are insufficient reserves to satisfy existing imbalance positions. Then a payable or a receivable, as appropriate, is recorded equal to the net value of the imbalance. As of December 31, 2004, the Company had recorded a net liability of approximately $850,000, representing approximately 500,000 MCF at an average price of $1.70 per MCF, related to imbalances on properties at or nearing depletion. The net liability accrued as of December 31, 2003, was approximately $1.1 million for approximately 379,000 MCF at an average price of $2.95 per MCF. The gas imbalances were valued using the price at which the imbalance originated if there is a gas balancing agreement or the current price where there is no gas balancing agreement. Reserve reductions on any fields that have imbalances could cause this liability to increase. Settlements are typically negotiated, so the per MCF price for which imbalances are settled could differ among wells and even among owners in one well. Exclusive of the liability recorded for properties at or nearing depletion (see discussion above), the Company’s remaining unrecorded imbalance, valued at current prices, would be approximately a $593,000 liability.

      The Company records receivables at their net realizable value with specific write off of receivables that are not deemed to be collectible. Joint interest billing receivables represent those amounts due to the Company as operator of an oil and gas property by the other working interest owners. Since these owners could also be the operator of other properties in which the Company is a working interest owner, the interdependency of the owners tends to assure timely payment. Balances that are past due for more than 90 days and over $30,000 are reviewed for collectibility quarterly, and are charged against earnings when the potential for collection is determined to be remote. The Company recognized such bad debt expense, included in interest and other income on the Consolidated Statement of Operations, of $441,000 and $185,000 related to such receivables for the years ended December 31, 2004 and 2002, respectively. In 2003 the Company made full or partial collection of several previously written off balances for a net gain

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

of approximately $109,000. At December 31, 2004, two outstanding balances account for approximately 25% and 20% of the total receivable balance, respectively, and approximately 51% of that outstanding balance is less than 30 days old. No other customers account for more than 10% of the Company’s outstanding receivables. The Company does not have any off-balance sheet credit exposure related to its customers.

      From time to time, certain other receivables are created and may be significant. At December 31, 2003, the Company had recorded a receivable of approximately $1.5 million from a private oil and gas company representing six months of override revenue. On November 8, 2004, the Company received $1.5 million as full payment of this receivable. At December 31, 2003, the Company had recorded a receivable of approximately $2.4 million from its insurance carrier, representing repair costs incurred as a direct result of hurricane Lili in 2002. In May 2004, the Company received $2.45 million from its insurance carrier as final settlement for this hurricane damage claim.

      The approximately $24.9 million shown as cash held for reinvestment on the Consolidated Balance Sheet dated December 31, 2003 represents the net proceeds of the oil and gas property sales that were closed during the fourth quarter of 2003. The Company’s credit facility requires that sale proceeds in excess of $5.0 million be reinvested in approved replacement oil and gas properties. The Company reinvested the sale proceeds by acquiring the Jalmat field in the Permian Basin on January 30, 2004.

      The other assets line on the Consolidated Balance Sheet contains items such as deferred financing costs, refundable deposits and equity investments. As of December 31, 2004, $7.6 million, or 90% of the $8.4 million balance in other assets consisted of deferred financing costs. We amortize our deferred financing costs monthly, over the life of the underlying debt agreement, to interest and related expenses. For the year ended December 31, 2004 we amortized $1.7 million of our deferred financing costs.

      Deferred taxes are accounted for under the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The ultimate realization of deferred tax assets is dependent upon the recognition of future taxable income in periods when the temporary differences are available. The effect on deferred taxes of a change in tax rates is recognized in income in the period the change occurs.

      For cash flow presentation purposes, the Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Interest paid in cash for the years ended December 31, 2004, 2003 and 2002, was $17.7 million, $26.7 million, and $26.4 million, respectively. Net cash tax refunds of approximately $0.5 million and $1.8 million were received in the years ended December 31, 2003 and 2002, respectively. Cash taxes of $481,000 were paid in the year ended December 31, 2004.

      The Company issued 16.75 million shares of its common stock in exchange for $40 million of the 10⁷/8% senior subordinated notes due 2007 in three separate non cash transactions in December 2003, February 2004 and March 2004.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      During 1993, the Company adopted the Mission Resources Simplified Employee Pension Plan (the “Savings Plan”) whereby all employees of the Company are eligible to participate. The Savings Plan is administered by a Plan Administrator appointed by the Company. Eligible employees may contribute a portion of their annual compensation up to the legal maximum established by the Internal Revenue Service for each plan year. The Company matches contributions up to a maximum of 6% each plan year. Employee contributions are immediately vested and employer contributions have a four-year vesting period. Amounts contributed by the Company to the Savings Plan for the years ended December 31, 2004, 2003 and 2002 were approximately $345,000, $335,000, and $96,000, respectively.

      In late 1997, the Company adopted the Mission Deferred Compensation Plan. This plan allowed selected employees the option to defer a portion of their compensation until their retirement or termination. Such deferred compensation was invested in any one or more of six mutual funds managed by a fund manager at the direction of the employees. The market value of these investments was included in current assets at December 31, 2002 and was approximately $419,000. An equivalent liability due to the plan participants was included in current liabilities. In June 2003, the Company terminated the Mission Deferred Compensation Plan, and the fund manager made final distributions of all funds held in the plan to the plan participants. Both the current asset and the current liability of approximately $111,000 related to the plan at the termination date were removed from the Balance Sheet.

      At December 31, 2004, the Company has two active stock-based employee compensation plans: the 1996 Stock Incentive Plan and the 2004 Stock Incentive Plan. The 2004 Plan was approved by the Board of Directors on March 4, 2004 and by the Company’s stockholders at the May 19, 2004 annual stockholders’ meeting. One inactive plan, the 1994 Stock Incentive Plan, still has options outstanding that have not expired or been exercised; however, no new options can be granted under the plan. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income for options granted under those plans with an exercise price equal to the market value of the underlying common stock on the date of the grant. Net income would be affected; however, if the exercise price of the option differed from the market price.

      SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation and to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. SFAS No. 148 amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation and FASB Statement No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure to stock-based employee compensation (amounts in thousands, except per share amounts).

      SFAS No. 142, Goodwill and Other Intangible Assets was approved in June 2001. This pronouncement requires that intangible assets with indefinite lives, including goodwill, cease being amortized and be evaluated on an annual basis for impairment. The Company adopted SFAS No. 142 on January 1, 2002 at which time the Company had unamortized goodwill, related to the Bargo merger, in the amount of $15.1 million and unamortized identifiable intangible assets in the amount of $374,300, all subject to the transition provisions. Upon adoption of SFAS No. 142, $277,000 of workforce intangible assets recorded as unamortized identifiable assets was subsumed into goodwill and was not amortized as it no longer qualified as a recognizable intangible asset.

      The transition and impairment test for goodwill, effective January 1, 2002, was performed in the second quarter of 2002. As of January 1, 2002, the Company’s fair value exceeded the carrying amount; therefore, goodwill was not impaired. Mission designated December 31st as the date for its annual test. Based upon the results of such test at December 31, 2002, goodwill was fully impaired and a write-down of $16.7 million was recorded.

      The changes in the carrying amount of goodwill for the period ended December 31, 2002, are as follows (amounts in thousands):

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      Comprehensive income includes all changes in a company’s equity except those resulting from investments by owners and distributions to owners. The accumulated balance of other comprehensive income related to cash flow hedges, net of taxes, is as follows (in thousands):

      Effective January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. This statement establishes accounting and reporting standards requiring that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded at fair value and included in the balance sheet as assets or liabilities. The accounting for changes in the fair value of a derivative instrument depends on the intended use of the derivative and the resulting designation, which is established at the inception of a derivative. Accounting for qualified hedges allows a derivative’s gains and losses to offset related results on the hedged item in the Consolidated Statement of Operations. For derivative instruments designated as cash flow hedges, changes in fair value, to the extent the hedge is effective, are recognized in Other Comprehensive Income until the hedged item is recognized in earnings. Hedge effectiveness is measured at least quarterly based upon the relative changes in fair value between the derivative contract and the hedged item over time. Any change in the fair value resulting from ineffectiveness, as defined by SFAS No. 133, is recognized immediately in earnings.

      In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which provided accounting requirements for retirement obligations associated with tangible long-lived assets. SFAS No. 143 requires that the Company record a liability for the fair value of its asset retirement obligation, primarily comprised of its plugging and abandonment liabilities, in the period in which it is incurred if a reasonable estimate of fair value can be made. The liability is accreted at the end of each period through charges to operating expense. The amount of the asset retirement cost is added to the carrying amount of the related asset and this additional carrying amount is depreciated over the life of the asset.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      The Company adopted the provisions of SFAS No. 143 with a calculation effective January 1, 2003. The Company’s assets are primarily working interests in producing oil and gas properties and related support facilities. The life of these assets is generally determined by the estimation of the quantity of oil or gas reserves available for production and the amount of time such production should require. The cost of retiring such assets, the asset retirement obligation, is typically referred to as abandonment costs. The Company hired independent engineers to provide estimates of current abandonment costs on all its properties, applied valuation techniques appropriate under SFAS No. 143, and recorded a net initial asset retirement obligation of $44.3 million on its Consolidated Balance Sheet. An asset retirement cost of $14.4 million was simultaneously capitalized in the oil and gas properties section of the Consolidated Balance Sheet. The adoption of SFAS No. 143 was accounted for as a change in accounting principle. The following table shows the changes in the asset retirement obligation that have occurred since its implementation in 2003 (in thousands):

      Staff Accounting Bulletin (“SAB”) No. 106, regarding the application of FASB Statement No. 143, Accounting for Asset Retirement Obligations, by oil and gas producing companies following the full cost accounting method was issued in September 2004. SAB 106 provided an interpretation of how a company, after adopting Statement 143, should compute the full cost ceiling to avoid double-counting the expected future cash outflows associated with asset retirement costs. The provisions of this interpretation have been applied by the Company and has no impact on the financial statements.

      SFAS No. 123R, Share-Based Payments was issued in December 2004. SFAS No. 123R requires public companies to measure the cost of employee services in exchange for an award of equity instruments based on a grant-date fair value of the award (with limited exceptions), and that cost must generally be recognized over the vesting period. SFAS No. 123R amends the original SFAS No. 123 and 95 that had allowed companies to choose between expensing stock options or showing pro forma disclosure only. SFAS No. 123R becomes effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The impact of SFAS No. 123R is dependent upon grants issued and; therefore, cannot be estimated at this time.

      Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities as well as reserve information which affects the depletion calculation and the computation of the full cost ceiling limitation

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

to prepare these financial statements in conformity with generally accepted accounting principles in the United States. Actual results could differ from these estimates.

      Certain reclassifications of prior period statements and disclosures have been made to conform to current reporting practices.

      During the last three fiscal years, the Company has completed or made the following significant acquisitions and investments:

      On January 30, 2004, the Company closed the $26.6 million acquisition of the Jalmat field in the Permian Basin of New Mexico. On April 13, 2004, the Company acquired an additional 14% working interest in the Jalmat field in Lea County, New Mexico for $3.6 million cash, before customary adjustments. These acquisitions added approximately 34.3 BCFE of proved reserves. After completion of this transaction the Company owns approximately a 94.5% operated working interest in the Jalmat field.

      On December 21, 2004, the Company acquired additional working interests in the Chocolate Bayou, Southwest Lake Boeuf, Backridge and West Lake Verret fields for approximately $11.0 million, before customary adjustments. The net reserves attributable to the interests being acquired are approximately 6 BCFE. The interests acquired approximately double the Company’s current ownership in the fields and the Company is currently the operator of these fields.

      In 2003 spending for oil and gas property acquisitions was approximately $1.5 million. The most significant individual acquisition was that of an additional 13.6% interest in High Island 553 for approximately $621,000. The Company did not make any significant oil and gas property acquisitions during 2002.

      Mr. J. P. Bryan, a member of Mission’s board of directors until October 2002, was Chairman and CEO of Mission from August 1999 through May 2000. Mr. Bryan is also Senior Managing Director of Torch Energy Advisors (“Torch”) and owns shares representing 79.5% of the shares of Torch on a fully diluted basis. In 2002 and 2003, Torch performed services for Mission under various contracts. All contracts with Torch were terminated effective April 1, 2003. The nature of services and amounts of the fees paid to Torch are summarized in the following table (amounts in thousands).

     Mission currently uses an Oracle platform provided by P2 Energy Solutions under a July 2002 hosting agreement. Torch owns 21.2% of P2 Energy Solutions as the result of a January 15, 2003 merger of its Novistar subsidiary with Paradigm Technologies, a Petroleum Place company, that created P2 Energy Solutions. Mission paid hosting fees of $415,000, $667,000 and $373,000 in the years ended December 31, 2004, 2003 and 2002, respectively.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      In July 2002, Mission sold interests in several properties located in New Mexico to Chisos, LTD (“Chisos”). J.P. Bryan is the President and sole owner of Chisos. The $4.0 million bid from Chisos exceeded the highest of the three other bids by $250,000 and provided Mission a non-competition agreement in New Mexico, a one-year right to participate in developmental drilling and a one-year right to participate in any preferential rights events. These considerations were not offered to Mission by any other bidder.

      A $250,000 payment under a non-compete agreement was paid in the second quarter of 2002 to Tim J. Goff, Bargo’s former Chief Executive Officer and former member of Mission’s board of directors.

      In connection with the reorganization of the Mission’s management team in 2002, the Company entered into separation agreements with each of Douglas G. Manner, Jonathan M. Clarkson, and Daniel P. Foley, on July 31, 2002, September  20, 2002, and November 15, 2002, respectively. Messrs. Manner, Clarkson and Foley were previously employed by the Company pursuant to employment agreements that provided for the payment of severance upon separation from the Company based on multiples of their current salary at the time of separation. The Company negotiated severance payments for each of Messrs. Manner, Clarkson and Foley that were considerably less than the amounts provided under their respective employment agreements. Under the terms of the separation agreements, the Company paid Messrs. Manner, Clarkson and Foley total payments of $1.3 million, $1.5 million and $450,000, respectively. Of the total $3.3 million, $250,000 was deferred and was amortized to expense over the term of the consulting contract and the remainder was charged to general and administrative expenses in 2002. Messrs. Manner, Clarkson and Foley also surrendered all of their options or rights to acquire the Company’s securities. In addition, the Company agreed to provide Messrs. Manner and Clarkson with certain insurance benefits for up to 24 months after the separation date, and, to the extent the coverage or benefits received are taxable to either of Messrs. Manner or Clarkson, the Company agreed to make them “whole” on a net after-tax basis. Messrs. Manner and Clarkson also agreed to provide certain consulting services to the Company following their separation dates. In January 2003, Mr. Manner received a pay out in the sum of $314,852 from the Company’s Deferred Compensation Plan made up primarily of deferred salary and bonuses under the terms of the plan

      Effective November 17, 2004, the Company entered into a Severance Agreement with Joseph G. Nicknish. Mr. Nicknish previously held the position of Senior Vice President, Operations and Engineering. Pursuant to an employment agreement with Mr. Nicknish, upon separation from the Company, the employment agreement provided for the payment of a severance amount based on multiples of his current salary at the time of separation. Under the terms of the Severance Agreement, the Company agreed to pay Mr. Nicknish a severance amount of $500,000 payable in three equal installments commencing on December 30, 2004 and ending June 30, 2005. Under various programs, Mr. Nicknish had been granted 574,499 options to acquire the Company’s common stock. Upon separation, these options were deemed exercisable for a period equal to the lesser of (i) one year following the separation date or (ii) the remaining term of the applicable option. In addition, the Company agreed to provide Mr. Nicknish with certain insurance benefits for up to 18 months after the separation date.

      The Certificate of Incorporation of the Company initially authorized the issuance of up to 30,000,000 shares of common stock and 1,000,000 shares of preferred stock, the terms, preferences, rights and restrictions of which are established by the Board of Directors of the Company. In May 2001, the number of authorized shares was increased to 60 million shares of common stock and 5 million shares of preferred stock.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      On May 16, 2001, Bellwether merged with Bargo Energy Company (“Bargo”). The resulting company was renamed Mission Resources Corporation. As partial consideration in the merger, 9.5 million shares of Mission common stock were issued to the holders of Bargo common stock and options. The $80.0 million assigned value of such shares was included in the purchase price.

      On December 17, 2003, the Company entered into a purchase and sale agreement with FTVIPT — Franklin Income Securities Fund and Franklin Custodian Funds — Income Series providing for the issuance of 4.5 million shares of the Company’s common stock in exchange for the surrender by the Franklin entities of $10.0 million aggregate principal amount of the Company’s 10⁷/8% Notes due 2007. Accrued interest on the notes to the date of the agreement was paid on April 1, 2004, the regularly scheduled interest payment date for the notes, or upon the occurrence of certain other events

      On February 25, 2004, the Company acquired $15 million of its 10⁷/8% Notes due 2007 from Stellar Funding, Ltd. in exchange for 6.25 million shares of the Company’s common stock. On March 15, 2004, the Company acquired an additional $15 million of its 10⁷/8% Notes due 2007 from Harbert Distressed Investment Master Fund, Ltd. in exchange for 6.0 million shares of the Company’s common stock.

      On April 8, 2004, Mission issued 312,000 shares of its common stock in lieu of cash to its financial advisors as a fee for services rendered during the debt refinancing discussed below in Note 8. The $1.2 million fair value of this consideration was recorded as deferred financing costs in the other assets line of the Consolidated Balance Sheet.

      Certain restrictions contained in the Company’s loan agreements limit the amount of dividends that may be declared. There is no present plan to pay cash dividends on common stock as the Company intends to reinvest its cash flows for continued growth of the Company.

      In September 1997, the Company adopted a shareholder rights plan to protect Mission’s shareholders from coercive or unfair takeover tactics. Under the shareholder rights plan, each outstanding share of Mission’s common stock and each share of subsequently issued Mission common stock has attached to it one right. The rights become exercisable if a person or group acquires or announces an intention to acquire beneficial ownership of 15% or more of the outstanding shares of common stock without the prior consent of the Company. When the rights become exercisable each holder of a right will have the right to receive, upon exercise of the right, a number of shares of common stock of the Company which, at the time the rights become exercisable, have a market price of two times the exercise price of the right. The Company may redeem the rights for $.01 per right at any time before they become exercisable without shareholder approval. The rights will expire on September 26, 2007, subject to earlier redemption by the board of directors of the Company.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      The following represents the reconciliation of the numerator (income) and denominator (shares) of the earnings per share computation to the numerator and denominator of the diluted earnings per share computation (amounts in thousands, except per share amounts):

      Potentially dilutive options that are not in the money are excluded from the computation of diluted earnings per share because to do so would be antidilutive. For the years ended December 31, 2004, 2003 and 2002, the potentially dilutive options excluded represented 819,498, 1,171,500 and 1,050,500 shares, respectively.

      In periods of loss, the effect of potentially dilutive options that are in the money are excluded from the calculation of diluted earnings per share. For the year ended December 31, 2002, potential incremental shares of 250,000, were excluded.

      In September 1998, the Company’s Board of Directors authorized the repurchase of up to $5.0 million of the Company’s common stock. As of December 31, 2002, 311,000 shares had been acquired at an aggregate price of $1.9 million. In the second quarter of 2003, the number of treasury shares increased to 389,323 because 78,323 shares were taken into treasury in lieu of collecting a note receivable valued at approximately $32,000. Treasury shares are valued at the price at which they are acquired, resulting in approximately $1.9 million being reported as a reduction to Stockholders’ Equity as of December 31, 2003 and 2004.

      The Company has stock option plans that provide for granting of options for the purchase of common stock to directors, officers and employees of the Company. These stock options may be granted subject to terms ranging from 6 to 10 years at a price equal to the fair market value of the stock at the date of grant. At December 31, 2004, there were 396,500 options available for grants.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      A summary of activity in the stock option plans is set forth below:

     Detail of stock options outstanding and options exercisable at December 31, 2004 follows:

      The estimated weighted average fair value per share of options granted during 2004, 2003, and 2002 was $7.64, $2.67, and $0.58, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes calculation was calculated as of year-end for 2002, but quarterly for 2003 and 2004 due to the quarterly reporting requirements of SFAS No. 148.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      The following weighted-average assumptions were used for each calculation

     A tax benefit related to the exercise of employee stock options of approximately $1.2 million in 2004 was allocated directly to additional paid in capital. Such benefit was not material in 2003 and 2002.

      Concurrent with the 2001 Bargo merger, all Bellwether employees who held stock options were immediately vested in those options upon closing of the merger. Related to those options, an additional $102,000 of compensation expense was recognized in the year ended December 31, 2002, as a result of staff reductions. The expense was calculated as the excess of the stock price on the merger date over the exercise price of the option.

      On November 5, 2003, the Compensation Committee of the Board of Directors awarded Robert L. Cavnar, our Chairman of the Board, President and Chief Executive Officer, 800,000 share appreciation rights. The rights had an initial value of $0.55 for each right granted, had a term of ten years and fully vest only upon the occurrence of a “change of control” or the termination of Mr. Cavnar’s employment by the Company without “cause” or by Mr. Cavnar for “good reason. On August 4, 2004, the Compensation Committee of the Board of Directors of the Company granted to Mr. Cavnar, a nonqualified option to acquire 800,000 shares of the Company’s common stock. This option was granted to replace the grant of 800,000 share appreciation rights made to Mr. Cavnar in November 2003. The option was granted under the 2004 Incentive Plan, has a term of 10 years, is fully vested and has a strike price of $0.55 per share, which is the same exercise price as the surrendered share appreciation rights. As a result of this option having an exercise price below the market value for the Company’s common stock at the time of issuance, the Company recognized a non-cash compensation expense of approximately $4.1 million ($2.6 million, net of tax) in the third quarter of 2004.

      The Company produces and sells crude oil, natural gas and natural gas liquids. As a result, its operating results can be significantly affected by fluctuations in commodity prices caused by changing market forces. The Company periodically seeks to reduce its exposure to price volatility by hedging a portion of its production through swaps, options and other commodity derivative instruments. A combination of options, structured as a collar, is the Company’s preferred hedge instrument because there are no up-front costs and protection is given against low prices. Such hedges assure that Mission receives NYMEX prices no lower than the price floor and no higher than the price ceiling. Hedging activities decreased revenues by $20.7 million, $15.8 million and $342,000 for the years 2004, 2003 and 2002, respectively.

      The Company’s 12-month average realized price, excluding hedges, for natural gas was $0.12 per MCF less than the NYMEX MMBTU price. The Company’s 12-month average realized price, excluding hedges, for oil was $1.47 per BBL less than NYMEX. Realized prices differ from NYMEX as a result of

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

factors such as the location of the property, the heating content of natural gas and the quality of oil. The gas differential stated above excludes the impact the Mist field gas production which is sold at an annually fixed price.

      In May 2002, several existing oil collars were cancelled. New swaps and collars hedging forecasted oil production were acquired. The Company paid approximately $3.3 million to counter parties, the fair value of the oil price collars at that time, in order to cancel the transactions. The cancellation of these hedges did not have an immediate impact on income. As required by SFAS No. 133, $418,000 related to the cancelled hedges had not yet been recognized in earnings. Such amount was amortized from other comprehensive income (“OCI”) over the period of the hedged transactions and has been fully amortized at December 31, 2003 to the interest and other income line of the Statement of Operations.

      In October 2002, the Company elected to de-designate all existing hedges and to re-designate them by applying the interpretations from the FASB’s Derivative Implementation Group issue G-20 (“DIG G-20”). The Company’s previous approach to assessing ineffectiveness excluded time value which was recorded to income currently. By using the DIG G-20 approach, because the Company’s collars and swaps meet specific criteria, the time value component is included in the hedge relationship and is recorded to OCI rather than income which reduces earnings variability. Both the realized and unrealized gains or losses related to these de-designated hedges at October 15, 2002 were amortized over the period of the hedged transactions. The Company’s hedge program resulted in hedge ineffectiveness recognized in the interest and other income line of the Consolidated Statement of Operations of a net gain of $108,000 and $985,000 for the years ended December 31, 2004 and 2003, respectively, and a net loss of $9.1 million for the year ended December 31, 2002.

      As the existing hedges, listed in the tables below, settle over the next two years, gains or losses in OCI will be reclassified. The amount expected to be reclassified over the next twelve months will be a $6.8 million loss.

      The following tables detail the cash flow commodity hedges that were in place at December 31, 2004.

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      The Company may also enter into financial instruments such as interest rate swaps to manage the impact of interest rates. Effective September 22, 1998, the Company entered into an eight and one-half year interest rate swap agreement with a notional value of $80.0 million. Under the agreement, Mission received a fixed interest rate and paid a floating interest rate. In February 2003, the interest rate swap was cancelled and the Company paid $1.3 million to the counter party.

      Fair value for cash, short-term investments, receivables and payables approximates carrying value. The commodity derivatives and the asset retirement obligations are also reflected on the Balance Sheet at fair value. The following table details the carrying values and approximate fair values of the Company’s other investments and long-term debt at December 31, 2004 and 2003 (in thousands):

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

      Long-term debt is comprised of the following at December 31, 2004 and 2003 (in thousands):

     Debt maturities by fiscal year are as follows (amounts in thousands):

      On April 8, 2004, the Company issued $130 million of 9⁷/8 Notes due 2011, announced the redemption of its 10⁷/8% Notes due 2007 and replaced both its revolving credit facility and its term loan. Those transactions and the details of the resulting debt are discussed below.

      On April 8, 2004, the Company issued $130.0 million of its 9⁷/8% Notes due 2011 which are guaranteed on an unsubordinated, unsecured basis by all of its current subsidiaries. Interest on the notes is payable semi-annually, on each April 1 and October 1, commencing on October 1, 2004.

      A portion of the net proceeds from the offering of the 9⁷/8% Notes was set aside to redeem, on May 10, 2004, the $87.4 million aggregate principal amount of the 10⁷/8% Notes that remained outstanding. On April 8, 2004, the remainder of the net proceeds from the offering of the 9⁷/8% Notes, together with $21.5 million that was advanced under the new senior secured revolving credit facility (as described below) and $25.0 million that was borrowed under the new second lien term loan (as described below), was used to completely discharge all of the Company’s outstanding indebtedness under its prior revolving credit facility and term loan.

      At any time on or after April 9, 2005 and prior to April 9, 2008, the Company may redeem up to 35% of the aggregate original principal amount of the 9⁷/8% Notes, using the net proceeds of equity offerings, at a redemption price equal to 109.875% of the principal amount of the 9⁷/8% Notes, plus accrued and unpaid interest. On or after April 9, 2008, the Company may redeem all or a portion of the

MISSION RESOURCES CORPORATION

Notes to Consolidated Financial Statements — (Continued)

9⁷/8% Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if redeemed during the twelve-month period beginning on April 9 of the years indicated below:

      If the Company experiences specific kinds of change of control, it may be required to purchase all or part of the 9⁷/8% Notes at a price equal to 101% of the principal amount together with accrued and unpaid interest.

      The 9⁷/8% Notes contain covenants that, subject to certain exceptions and qualifications, limit the Company’s ability and the ability of certain of its subsidiaries to: